Southern Inc. has EBIT of $3,500,000, and total capital of $20,000,000 that is 1

Question

Southern Inc. has EBIT of $3,500,000, and total capital of $20,000,000 that is 15% debt. There are 1,700,000 shares of stock outstanding which sell at book value. The firm pays 10% interest on its debt and is subject to a combined state and federal tax rate of 40%. Southern plans to restructure its capital to 60% debt.

a. Make a simple calculation that indicates whether at the current level of profitability more debt will enhance results? Draw a conclusion in fifteen words or less.
b. Calculate EPS, and DFL at the current and proposed structures using the following worksheet:

($000 except for EPS, DFL and Shares)

Current Proposed
EBIT $3,500 $3,500
Interest _______ _______
EBT _______ _______
Tax _______ _______
EAT _______ _______
DEBT _______ _______
EQUITY _______ _______
TOT CAP $20,000 $20,000
SHARES 1,700,000 _______
EPS _______ _______
DFL _______ _______

c. Use your results to point out two conflicting influences the change will have on stock price.

Explanation / Answer

I am attempting the question as far as i can i think you will get a idea how to follow

Question:

Southern Inc. has EBIT of $3,500,000, and total capital of $20,000,000 that is 15% debt. There are 1,700,000 shares of stock outstanding which sell at book value. The firm pays 10% interest on its debt and is subject to a combined state and federal tax rate of 40%. Southern plans to restructure its capital to 60% debt.

a. Make a simple calculation that indicates whether at the current level of profitability more debt will enhance results? Draw a conclusion in fifteen words or less.
b. Calculate EPS, and DFL at the current and proposed structures using the following worksheet:
($000 except for EPS, DFL and Shares)
Current Proposed
EBIT $3,500 $3,500
Interest _______ _______
EBT _______ _______
Tax _______ _______
EAT _______ _______
DEBT _______ _______
EQUITY _______ _______
TOT CAP $20,000 $20,000
SHARES 1,700,000 _______
EPS _______ _______
DFL _______ _______
c. Use your results to point out two conflicting influences the change will have on stock price.

Solution:

Current Proposed
EBIT $3,500 $3,500

It is mentioned that out of total capital of $20,000,000, 15% debt means debt is 20,000,000*0.15 = 3,000,000 $

For this debt we need to pay an intrest of 10% for current

3,000,000 *0.10 = 300,000 $

For proposed debt is of 60% means debt is 20,000,000*0.60 = 12,000,000

For this debt we need to pay an intrest of 10% for current

12,000,000 *0.10 = 1,200,000 $

Interest $300 $1,200

EBT = EBIT - Interet

EBT $3,200 $2,300

we need to pay a corporate tax of 40% so tax for current and proposed is 3,200*0.4 and 2,300*0.4 respectively

Tax $1,280 $920

EAT = EBT - Tax

EAT $ 1,920 $1,380
DEBT $ 3,000 $ 12,000
EQUITY $17,000 $8,000
TOT CAP $20,000 $20,000
SHARES 1,700 1,700

EPS is EAT/No of shares

EPS $ 1.13 $0.811
Degree of Financial Leverage (DFL)= EBIT / ( EBIT - Total Interest expense)

for current and proposed it is 3500/3200 and 3500/2300 respectively

DFL    1.09375 1.521

From this information hope you can answer the questions

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.